Survey
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
We Have Developed a Theoretical Model Capable of Explaining All the Stylised Facts So Now We Have a Theoretical Model Capable of Explaining All the Stylised Facts In fairness, some results depend on some effects being greater or less than others (e.g. hours worked, interest rates etc) It is an empirical question whether this is actually the case. So Now We Have a Theoretical Model Capable of Explaining All the Stylised Facts So we need to build a model economy like Chapters, 2, 4, 5 and 12, with realistic parameters for the production function, tastes for work and leisure, and investment function etc and check whether such an economy can replicate the observed stylised facts. Evaluation and Assessment • Readings (on reading list): • Ryan & Mullineux- The Ups and Downs of Modern Business Cycle Theory in Reflections on the Development of Modern Macroeconomics, Snowden & Vane eds For a contrary view see paper by Dixon in same volume Evaluation and Assessment • Additional readings which I have placed on the J drive: • Ryan - Business Cycle Theory: The Real Business Cycle in Encyclopaedia of Macroeconomics (Forthcoming 2002) • Ryan – Business Cycle Theory: The Stylised Facts Real Business Cycle in Encyclopaedia of Macroeconomics (Forthcoming 2002) Origins of the Real Business Cycle Theory 1. Theoretical Failures & Add ons 2. Lucas Critique 3. Rational Expectations Origins of the Real Business Cycle Theory 1. Theoretical Failures & Add ons r LM IS y 1970’s No Supply side in ISLM Model Demand Side model Only r LM IS y P1 P0 AD y1 y0 Then expected that if y went down P would fall. So when observed P rising and y falling needed new construct r P1 P0 LM Added on Supply IS which when we had rational expectations had to be vertical y AS1 AS0 AD y1 y0 No real Microeconomic Foundations Origins of the Real Business Cycle 2. Lucas Critique Can’t use reduced forms to evaluate policy e.g. recall macro last year y=c+i+G-T If c=a+byd where yd is disposable income and yd=(1-t)y Then dy 1 dG 1 b(1 t ) Origins of the Real Business Cycle dy 1 dG 1 b(1 t ) 2. Lucas Critique If change Government policy (e.g. G or T) then may change marginal propensity to consume, b. b is a derived parameter, and can’t rely on it Origins of the Real Business Cycle dy 1 dG 1 b(1 t ) 2. Lucas Critique Need to use basic theory such as utility and production functions not derived consumption functions such as c=a+byd Origins of the Real Business Cycle 3. Rational Expectations Up to 1970’s used to believe that Monetary Policy was very important BUT Rational Expectations showed that people could be expected to figure out the broad trust of monetary policy and thus ability if the government to ‘surprise’ them was limited So Monetary Policy is ineffective Origins of the Real Business Cycle 3. Rational Expectations Monetary Policy is ineffective If still believe that Money is important then need a proper model of how money works in the economy – not a crappy LM curve SO again need to return to a more basic model Origins of the Real Business Cycle Theory So have three reasons to return to basic micro modelling • Theoretical Failures & Add ons • Lucas Critique • Rational Expectations Origins of the Real Business Cycle Finally, a comment on shocks: What was causing a business cycle? How were these shocks propagated? Origins of the Real Business Cycle Old belief: Supply Shocks small Demand and Monetary Shocks more important. But if government monetary policy is anticipated then monetary shocks must be less important And Demand side shocks must be due to MPKe that is, supply side shocks that effect D SO need to look more closely at Supply side shocks! Real Business Cycle Model Original Kydland & Prescott (1982) Economica Utility Function Production Function U t Ct L t y t K t 1N t 1 1 CALIBRATING the Model Use MICRO econometric studies to decide on (the CES) form of the functions and appropriate values for and Utility Function Production Function U t Ct L t y t K t 1N t 1 1 WHY COBB-DOUGLAS Because Shares of K, N and C & L relatively constant over time: Remember 201 Test 1 Utility Function Production Function U t Ct L t .25 yt K Nt .33 t 1 .75 .66 Recall we said we could think of production function as – y Good year Normal Bad year N yt y Zt .33 t 1 K Nt Good year .66 But need to include a Normal shock Zt Bad year for good and bad years N 1 3 t 1 y t Zt K N t y Zt N 2 3 So now we are ready for our computer simulation model Stick the Utility function, the production function and the investment Function in the computer, switch it on and ……. y yG y0 yB N NB N0 NG And the computer churns out: • • • • • • N0, NB, NG,……………… y0, yB, yG,……………… c0, cB, cG,……………… i0, iB, iG,……………… p0, pB, pG,……………… Etc etc for each state Zt • And now we are almost there: • All we have to do now is look at how each variable fluctuates compared with real economy • So how do we do? Evaluation • How does the Model Do? • Answer: Simulation is reasonably CLOSE except for variability of hours worked • But how can we be sure this is a good model? • Some controversy!! Evaluation 1. Are the facts a fact? • Vary across time – E.g. Prices between 1929+ 1939 – and 1945 - now • Vary across country – broad results the same some difference • How are these facts determined? – How do we fit the Long Run Trend Line Evaluation 2. How Close is CLOSE? • No measure of Closeness – Not like Confidence Interval in Econometrics • Can perform sensitivity tests – Use slightly different parameters for utility and production functions – New econometric techniques developed to cope with problem – Generalised Method of Moments Evaluation 3. The need for labour Market modifications a) 40 Hour Week b) Allowing the intensity with which capital is worked to vary c) recognising that work effort in one period might influence desire to work in the next All these things improve performance of the model • Results of Exercise Topic 7 Bottom Line: • Changes in w/p over the cycle will not induce much variation in hours worked • However, changes in overtime rates will (pure substitution effect) • Main effect will be on marginal individual making the work/no-work decision • In particular for higher w/p people are more likely to make the effort to be in employment What are the implications of this for our Labour Demand & Supply diagrams? W/P lD lS W/P lD lS W/P lD lS lS’ ll lu W/P lD lS lS’ ll lu W/P lD lS lS’ ll lu W/P lD lS lS’ ll lu One other problem with labour market! • The Dunlop-Tarshis Test Policy implications: • Macroeconomic fluctuations are the result of optimal responses to economic shocks. • If responses are Optimal then Government can’t do any better • Short-run Government policy responses distorts these optimal responses • Particularly true of Monetary Policy Policy implications: • Doesn’t men no role for government • In fact would claim that the policy implications are very Keynesian in one sense • The structure of the economy is all important • So getting ‘balance and structure’ of government policy is absolutely vital for the long-run growth path of the economy Policy implications: • Not about Right Wing Policy Agenda • About Methodology • Must have Macroeconomics with proper micro-foundations • Better Labour market sector – but properly modelled ( Next part of Course) • Next development-a Proper modelled monetary Sector